Outrunning the Bear

When confronted by a hungry bear you don’t need to be faster than the bear, just faster than kid that ate all the Twinkies. Increasingly the global economy is looking similar with Europe being the bloated glutton. For all the problems in the United States the friends across the pond are looking more and more like bear food.

The problems in Greece, which in the recent past I wrote were not going to go gently into the night, rose up this week with a massive downgrade of their sovereign debt by S&P to junk status. There was political posturing to try to hold down the panic as a large piece of Greek debt was due to be rolled forward in May. It looks like that posture is unlikely to be upright as two-year interest rates on Greek bonds moved to 15% this week. The PIGS (Portugal, Ireland, Greece and Spain) are looking like crispy bacon.

In Club Med, Barclay’s analysts believe Greece needs 90 Billion Euros to get through the current crisis, Portugal, 40 Billion and Spain 350 Billion. The IMF runs dry at 200 Billion which would mean heating up the printing presses. If the other rating agencies follow S&P’s lead, the European Central Bank will not be able to hold Greek debt on its balance sheet. Or they will destroy the sanctity of the ECB, much as the Fed has done.

The crisis in Greece puts a stake in the heart of discussions of the Euro supplanting the dollar as the world’s reserve currency. The lack of a cohesive national government in time of crisis has been shown to be the weak underbelly of the European monetary union. The inability to enact independent monetary policy because of treaty obligations and mandates may well be the emperor has no clothes moment for the Euro.

If this lit fuse reaches Spain where there is serious German and British investment fireworks could ensue. The expectation of an imminent Fed rate hike is deflating by the day. If one looks back to 1997 a crisis in Thailand started the Asian crisis and quickly derailed plans for interest rate hikes.

Vampire Squid

A recent podcast by the radio program This American Life does an excellent job of describing the complexities of Collateral Debt Obligations in the episode ">The Inside Job.

Vampire Squid

Inside Job

http://feeds.thisamericanlife.org/talpodcast

Playing the Odds - to no avail

As a manager of clients whose primary focus is on long term gains and security, I have focused on risk before growth. In the past year, that was an uncomfortable focus as the stock market went on an almost unparalleled tear. Looking at historical precedent and market valuations has been off the mark this time.

Looking back to the pre-depression 1920's and analyzing markets shows just how unusual this past year has been. Using rolling time periods of just over a year, there have been 4,237 different outcomes in the market. The current gain places this period ahead of ALL market performance periods except during the Great Depression. This fact does not imply that the next period will be either positive or negative but a regression to the mean will certainly occur. Trees don't grow to heaven.





(click on image to enlarge)

This market rally was exceeded only in periods during 1933, 1934 and 1936.

John Barnyak

Pension Tsunami

When we look in practically any newspaper that reports municipal issues we find an ongoing friction between unionized public sector workers and management. Recently teachers in a local school district went on strike for improved contractual salary benefits and continued modest health care contributions that frankly make the rest of us glaze over with envy.

Behind the daily jostling for continuing generous retirement and health care benefits, on the not too distant horizon is a wall of trouble. In typical fashion we are kicking the issue down the road until the current embers turn into a fiscal inferno.

How voters and taxpayers will confront the coming crisis will be interesting to say the least because we sure aren't dealing with it adequately now. Public services we take for granted will clearly be jeopardized in years to come. In my activities on a local library board I am alarmed at the sanguine attitude that local municipal contributions for the operating expenses will continue to be available. When public pension contributions have to be increased dramatically through taxes to fund future obligations how deep will taxpayers dig for libraries, swimming pools, cultural events, fire and police protection, road maintenance etc. etc. etc?

Nationally, the municipal, state and local pension plans are currently underfunded by and estimated $2 to $2 TRILLION. Future pension plans will have to be terminated and defined contribution plans put in their place. Future benefits will become a battle royale when private sector neighbor eyes public sector neighbor with envy and anger. Let's get ready to rumblllllle.

The interactive chart below shows various pension plans in each state and their level of funding.

Powered by Tableau

John Barnyak

Jim Grant Takes on the Maestro

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Flesh eating fish and a dolphin

As I read about the developments in the national residential real estate market I am struck the images. First is the return of the flipper. Whereas five years ago every cab driver and school teacher in Florida and Nevada was playing the home edition of Monopoly and lining up houses on Baltic Avenue, today it is a more sophisticated and serious investor. Some might say vulture. They do their homework, look at distressed houses with a dispassionate eye and a full checkbook. Scores of investors with hearts of stone are nibbling like Chinchin Yu (the Chinese dead skin munching pedicure fish)on the housing market and cleaning up the dead skin.

From an economic perspective this is a good thing. Whereas the banks and government have played a game of extend and pretend with the financial side of housing, until prices reach a level for existing housing stock to clear, the pain will be prolonged.
The price of a house is that at which buyer and seller agree. It is not the price that the bank holding the amalgam of sub-prime mortgages wants it to be.

The foreclosure process forces banks to recognize an asset as worth much less than the balance sheet would like. Like the Japanese banks of the past twenty years, pretending that the underlying collateral of loans is worth as much as the debt outstanding when the market says it is not is the only thing that keeps the bank solvent and unable to lend in the interest of economic growth. There have been serious and workable solutions to the housing overhang, but they would require banks recognizing the pain and creating a "housing appreciation note." Such a vehicle would mean the possibility of the bank being made whole at some point in the future, but also of recognizing the diminished current value while trying to clear the logjam.

Rather like my wife saying to me, "you are never sick BECAUSE you never go to the doctor!" It is a system that has focused more on emergency triage than well banking care.